Rising Interest Rates and Startups

The Impact Rising Interest Rates Have On Startups

You’ve probably heard that interest rates are rising but shrugged it off – and why wouldn’t you? You’re a startup on the cusp of a mega technological breakthrough and you have what people want, or don’t know they need yet  – so why should interest rates impact you?

Think again.

 

First – A Federal Interest Rates Crash Course

The United States Federal Reserve System (aka the FED) is tasked with safeguarding the stability and economy of the United States. There are a lot of tasks associated with that responsibility, such as regulating and supervising the way banks operate, strengthening the position of the U.S dollar against global currencies and more. But, the task of particular importance to us is the FED’s responsibility of managing the money supply. What this effectively does prevents inflation and deflation, maximizes employment, and stabilizes long-term interest rates.  

The strongest tool available for managing money supply is adjusting interest rates, which is simply the rate banks charge one another for overnight lending. The interest rate generally fluctuates, however between January and December 2008, it went from 3.5% to a staggeringly low 0.25%. It remained there until December 6th, 2015, when it made a small jump to 0.5%.

 

Why Startup Founders Should Care

Unless you have friends and family willing to put their money behind you and your business, you have few options when it comes to financing your big idea; take out a loan or go to a VC or Angel. 

While interest rates were low, money was essentially cheap, so more people were inclined to invest in potentially rewarding business ideas – especially when leaving the money in the bank yielded little to no profit, making almost any investment a good investment. This causes a rise in the valuation of startups and a frenzy from the investor’s side to invest in any idea that seems like aRising Interest Rates and Startups lucrative one. As Bill Gurley of Benchmark Capital once said, “valuations are at extreme levels because you cannot get a decent return on your money doing anything else.”

Simple logic, therefore, dictates that if money is cheap when interest rates are down, which causes investments to rise, money becomes ‘expensive’ when interest rates go up and as a result, investments decline. As with any other commodity, when the price goes up, the demand goes down, and this directly translates into less money floating around and less demand to find the next good idea that might yield a profit.

Investors who use their capital to leverage funds and invest borrowed money are the first to shift their investment approach when interest rates rise. Those seeking stable returns on their investments will suddenly find low-risk ones more appealing as interest rates go up.  

 

Startup Scene Survival

According to TechCrunch, in 2016, VC’s raised more money than they had in a decade. A total of $12 billion was raised in the first quarter of last year by just 57 U.S. VC’s – a move likely done in anticipation of rising interest rates. Beyond signaling to startups that there is still money to put into good ideas, this reaffirms our confidence when we say that the startup scene can – and will – survive.  

$12 billion was raised in the first quarter of 2016 by only 57 U.S. #VC’s says @TechCrunch Click To Tweet

It’s important to remember that rising interest rates also mean a blossoming economy – and when the economy does well, businesses tend to spend more on innovation and R&D, leaving more possibilities for startups looking to work in a collaborative nature with enterprises. While bargain deals in which founders will get a lot of money for a small piece of equity will likely happen less and less frequently, and startups will have to work harder to prove that their product is viable, those startups who run successful PoC’s with large scale enterprises and prove their product, will come out on top.

And what better place to run a PoC and show your product has what it takes to change an industry than on prooV’s end-to-end, proof-of-concept platform?